The J.P. Morgan Settlement: Misconceptions Debunked

For the past few years, capital markets have lived by the golden rule of not pushing against the easy-money policies of the U.S. central bank. Following last Tuesday’s mortgage settlement between J.P. Morgan Chase & Co. and the Justice Department, banks should abide by a slightly amended version of that maxim: Don’t fight the Feds.

That, to use banker-speak, is the “main take-away” from the $13 billion penalty paid by the largest U.S. lender by assets to settle civil claims brought by several federal and state authorities. When the government comes after a corporation armed with evidence provided by a whistleblower, as the Justice Department did with J.P. Morgan, and the determination to claim a big victory, the room for negotiation is limited.

That much is clear. Many other aspects of this record-breaking settlement between a U.S. company and the government, however, remain murky.

Among them: Why the Justice Department and national and state regulators picked J.P. Morgan as the first bank to be pursued for such large claims; how the authorities computed and sliced the settlement amount (how did the state of Delaware get the precise sum of $19.7 million?); J.P. Morgan’s decision to kick up a last-minute fuss on its right to sue the Federal Deposit Insurance Corp. to get some of the settlement money back, only to capitulate when the authorities said no; and the way the Justice Department announced the final deal—a shortish release with no news conference. People familiar with the situation said logistical reasons made it complicated to call a news conference.

The density of the fog surrounding the deal has given cover to a few misleading claims on its implications. Here are three of the most common.

J.P. Morgan shareholders are the biggest losers from the entire affair.

That is technically true: The bank will pay the $13 billion out of reserves that could otherwise have been invested in the business or returned to investors through dividends or share buybacks. But that is only part of the story. For a start, some $7 billion is eligible for tax deductions, enabling the company and, by extension, its owners to save a pretty penny on tax bills. Second, removing the uncertainty of the case has helped the stock. Since last Tuesday, the bank’s shares are up more than 3%, outperforming the market. If this trend continues, by next week J.P. Morgan’s market value would have increased by more than the $13 billion it paid the government, a testament to the strength of its business.

Holding J.P. Morgan liable for the acts of Bear Stearns Cos. and Washington Mutual Inc., which it acquired during the financial crisis, will make such deals impossible in the future.

J.P. Morgan Chief Executive Officer James Dimon said as much. “A Bear Stearns deal would not happen again that way, we simply wouldn’t undertake it,” he told investors after the settlement.

This argument assumes that shotgun marriages like the ones consummated in 2008 would be the norm in future crises. That is hard to believe. Regulators and banks are working on rules to allow troubled lenders to go under without threatening the financial system. Even if those measures were to prove faulty, a distinct possibility in the hurly-burly of a crisis, the different circumstances and personalities make it unlikely the authorities would use an old playbook to resolve new problems. This is especially the case when they have other options, such as breaking banks up into their constituent parts instead of creating ever-larger behemoths through mergers.

Other big banks are in line for severe punishments a la J.P. Morgan

That seems logical. Mr. Dimon’s firm wasn’t alone in bundling mortgages and selling them to investors. But because the Justice Department didn’t detail how it arrived at a settlement, it is unclear how it will deal with other banks.

The evidence it has, and the presence or lack of whistleblowers, will surely influence future moves. The ability of an institution to withstand a large fine and stay in business could also play a part, as will the political climate surrounding the banking sector. History may rhyme but would almost certainly not repeat itself. Meanwhile, one data point stands out: Shares in Bank of America Corp., a giant mortgage player during the crisis, have done even better than J.P. Morgan’s since last Tuesday.

The outcomes may differ, but when the government comes knocking on the next bank’s door, CEOs would do well to remember: Don’t fight the Feds.

Francesco Guerrera is The Wall Street Journal’s financial editor. Write to him at: currentaccount@wsj.com and follow him on Twitter: @guerreraf72.